Low Rates May Do Little to Entice Nervous Consumers

The Federal Reserve’s announcement last weekthat it intended to keep credit cheap for at least two more years was a clear invitation to Americans: Go out and borrow.

But many economists say it will take more than low interest rates to persuade consumers, a crucial driver of the nation’s economy, to take on more debt.

There are already signs that the recent stock market upheaval, turbulence in Europe and gridlock in Washington over the federal deficit have spooked consumers. On Friday, preliminary data showed that the Thomson Reuters/University of Michigan consumer sentiment index had fallen this month to lower than it was in November 2008, when the country was deep in recession .

Under normal circumstances, the Fed’s announcement might have attracted new home and car buyers and prompted credit card holders to rack up fresh charges. But with unemployment high and those with jobs worried about keeping them, consumers are more concerned about paying off the loans they already have than adding more debt. And by showing its hand for the next two years, the Fed may have inadvertently invited prospective borrowers to put off large purchases.

Lenders, meanwhile, are still dealing with the effects of the boom-gone-bust and are forcing prospective borrowers to go to extraordinary lengths to prove their creditworthiness.

“I don’t think lenders are going to be interested in extending a lot of debt in this environment,” said Mark Zandi, chief economist of Moody’s Analytics, a macroeconomic consulting firm. “Nor do I think households are going to be interested in taking on a lot of debt.”

In housing, consumers have already shown a lackluster response to low rates. Applications for new mortgages have slowed this year to a 10-year low, according to the Mortgage Bankers Association. Sales of furniture and furnishings remain 22 percent below their prerecession peak, according to MasterCard Advisors SpendingPulse, a research service.

Credit card rates have actually gone up slightly in the last year. The one bright spot in lending is the number of auto loans, which is up from last year. But some economists say that confidence among car buyers is hitting new lows.

For Xavier Walter, a former mortgage banker who with his wife, Danielle, accumulated $70,000 on a home equity line and $20,000 in credit card debt, low rates will not change his spending habits.

As the housing market topped out five years ago, he lost his six-figure income. He and his wife were able to modify the mortgage on their four-bedroom colonial in Medford, N.J., as well as negotiate lower credit card payments.

Two years ago, Mr. Walter, a 34-year-old father of three, started an energy business. He has sworn off credit. “I’m not going to go back in debt ever again,” he said. “If I can’t pay for it in cash, I don’t want it.”

Until now, one of the biggest restraints on consumer spending has been a debt hangover. Since August 2008, when household debt peaked at $12.41 trillion, it has declined by about $1.2 trillion, according to an analysis by Moody’s Analytics of data from the Federal Reserve and Equifax, the credit agency. A large portion of that, though, was simply written off by lenders as borrowers defaulted on loans.

By other measures, households have improved their position. The proportion of after-tax income that households spend to remain current on loan payments has fallen, from close to 14 percent in early 2007 to 11.5 percent now, according to Moody’s Analytics.

Still, household debt remains high. That presents a conundrum: many economists argue that the economy cannot achieve true health until debt levels decline. But credit, made attractive by low rates, is a time-tested way to bolster consumer spending.

With new risks of another downturn, economists worry that it will take years for debt to return to manageable levels. If the economy contracts again, said George Magnus, senior adviser at UBS, then “you could find a lot of households in a debt trap which they probably can never get out of.”

The market most directly affected by the reluctance to borrow is housing. With many owners still owing more than the current value of their homes, they cannot sell and move up to new homes. New mortgage and refinancing loan volumes fell nearly 19 percent, to $265 billion, at the end of the second quarter, down from $325 billion in the first quarter, the lowest since 2008, according to Inside Mortgage Finance, an industry newsletter.

FEELING THE BURN

Mortgage lenders, meanwhile, burned by the housing crash, are extra careful about approving new loans. In June, for instance, Fannie Mae, the nation’s largest mortgage buyer, said that borrowers whose existing debt exceeded 45 to 50 percent of their income would be required to have stronger “compensating” factors, which might include higher savings.

Even those borrowers in strong financial positions are asked to provide unusual amounts of paperwork. Bobby and Katie Smith have stellar credit, tiny student debt and a combined six-figure income. For part of their down payment, they planned to use about $5,000 they had received as wedding gifts in February.

But the lender would not accept that money unless the Smiths provided a certified letter from each of 14 guests, stating that the money was a gift, rather than a loan.

“We laughed for a good 15 or 20 minutes,” recalled Mr. Smith, 34.

Mr. Smith, a program director for a radio station in Orlando, Fla., said they ended up using other savings for their down payment to buy a $300,000 four-bedroom ranch in April.

For those not as creditworthy as the Smiths, low rates are irrelevant because they no longer qualify for mortgages. That leaves the eligible pool of loan applicants wealthier, “older and whiter,” said Guy D. Cecala, publisher of Inside Mortgage Finance. “It’s creating much more of a divide,” he said, “between the haves and the have-nots.”

Car shoppers with the highest credit ratings can also get loans more easily, and at lower rates, said Paul C. Taylor, chief economist of the National Automobile Dealers Association.

During the recession, inability to obtain credit severely curtailed auto buying as lenders rejected even those with good credit. Now automakers are increasing their subprime lending again as well, but remain hesitant to approve large numbers of risky customers.

The number of new auto loans was up by 16 percent in the second quarter compared with the previous year, said Melinda Zabritski, director of automotive credit at Experian, the information services company.

But some economists warn that consumer confidence is falling. According to CNW Marketing Research, confidence among those who intend to buy a car this year is at its lowest since it began collecting data on this measure in 2000.

On credit cards, rates have actually inched slightly higher this year, largely because of new rules that curb the issuer’s ability to charge fees or capriciously raise certain interest rates.

At the end of the second quarter, rates averaged 14.01 percent on new card offers, up from 13.75 percent a year earlier, according to Mail Monitor, which tracks credit cards for Synovate, a market research firm. According to data from the Federal Reserve, total outstanding debt on revolving credit cards was down by 4.6 percent during the first half of the year compared with the same period a year earlier.

Even if the Fed’s move helps keep rates steady, or pushes them down, businesses do not expect customers to suddenly charge up a storm.

“It’s not like, ‘Oh, credit is so cheap, let’s go back to the heydays,’ ” said Elizabeth Crowell, who owns Sterling Place, two high-end home furnishing and gift stores in Brooklyn. “People still fear for their jobs. So I think where maybe after other recessions they might revert to previous spending habits, the pendulum hasn’t swung back the same way.”